Dissecting ‘Dispute’ and ‘Reference to Arbitration’ under Section 7 of IBC

By Shubham Kumar, a Fourth-Year Student at HNLU, Raipur

In Innoventive Industries Ltd. v/s ICICI Bank the Hon’ble Supreme Court has provided the scheme of Insolvency and Bankruptcy Code, 2016 (“IBC”) with respect to a section 7 application. An application u/s 7 can be filed on the occurrence of a default and ascertainment of the same through records of the information utility or other evidence produced by the corporate debtor. Contrasting the scheme of section 7 with section 9, it was also held that a dispute regarding debt is of no relevance until it is “due”. Therefore, if the Adjudicating Authority is satisfied with the existence of the financial debt and the default, it will admit the application u/s 7(5)(a).

Thus, a pre-existing dispute between the corporate debtor and financial creditor had no relevance for deciding a Section 7 application until the recent order of the National Company Law Tribunal (“NCLT“) Mumbai in Kotak India Venture Fund-I v/s Indus Biotech Private Limited.

‘Dispute’ in terms of section 7 and section 9

According to section 5(6) of IBC ‘dispute’ includes a suit or arbitration proceedings relating to:

  • the existence of the amount of debt;
  • the quality of goods and services; and
  • the breach of representation or warranty.

A corporate debtor may bring to the notice of the operational creditor, any pre-existing dispute between the parties. The application u/s 9 can be accepted only in the absence of a pre-existing dispute between the parties prior to the date of demand notice. The dispute can be related to an arbitration award in relation to a pre-existing dispute challenged by the parties or a dispute in relation to the amount claimed pending before an arbitral tribunal etc.

The Supreme Court in Mobilox Innovations v/s Kirusa Software held that the Adjudicating Authority has to be satisfied only to the extent that there exists a bona fide dispute between the parties. The court is not concerned with the outcome of the dispute.

However, while adjudicating upon an application u/s 7 the NCLT is not required to look into any pre-existing dispute between the parties. Overturning a decision of the Hon’ble NCLT, Chennai Bench where a section 7 application was dismissed on the grounds of a pre-existing dispute between parties and pendency of civil suit between them, the Hon’ble National Company Law Appellate Tribunal (“NCLAT“) in Vinayaka Exports and another v/s. M/s. Colorhome Developers Pvt. Ltd observed that only if an application is filed by an operational creditor, can the corporate debtor raise the defence of a pre-existing dispute.

Kotak Case: A Pandora’s box to section 7?

In the Kotak case, Kotak Private Equity Group (“Financial Creditor“) filed a section 7 application against Indus Biotech Private Limited (“Corporate Debtor”) for the failure to redeem Optionally Convertible Redeemable Preference Shares (“OCRPS“) amounting to Rs. 367,07,50,000 crores. The Corporate Debtor contested the claim of the Financial Creditor questioning its right to redeem such OCRPS when it had participated in the process of conversion of OCRPS into equity shares, including disputes raised regarding the valuation of Financial Creditor’s OCRPS and fixing of the QIPO date. The Corporate Debtor prayed before the Hon’ble NCLT to refer the parties to arbitration pursuant to Article 20.4 of the share subscription and shareholders agreement which contained an arbitration clause for resolving disputes between the parties.

The Hon’ble NCLT held that since there exists an arbitration clause and the dispute is capable of being arbitrated, the section 7 application cannot be admitted. The said decision of the NCLT raises three-fold concerns: firstly, with regard to the NCLTs’ power to refer a dispute to arbitration in a section 7 application, secondly, the overriding effect of Arbitration and Conciliation Act, 1996 (“Arbitration Act”) over IBC and lastly, the scope for raising a dispute in an application under Section 7.

  • NCLTs’ power to refer to arbitration in a Section 7 application

In Swiss Ribbon v/s Union of India the Hon’ble Supreme Court held that the Adjudicating Authority under IBC can exercise inherent powers given under Rule 11 of the NCLT Rules, 2016 which states that the NCLT has inherent powers to make such orders as may be necessary for meeting ends of justice or to prevent the abuse of process of the court. The inherent powers under Rule 11 are similar to the inherent power of the Company Law Board (“CLB”) under Regulation 44 which in turn is similar to the powers of the civil court u/s 151 of the Civil Procedure Code, 1909. In Union of India v. Paras Laminates (P.) Ltd. the Supreme Court has categorically held that tribunals function as court and being a judicial body, it has all those incidental and ancillary powers which are necessary to make fully effective the express grant of statutory power.

Further, the Hon’ble NCLAT in Thota Gurunath Reddy & Ors. v/s. Continental Hospitals Pvt. Ltd. & Ors. has held that: “…it is clear that under Section 420 of the Companies Act, 2013, the National Company Law Tribunal passes an order as a ‘Tribunal’, whereas under the provisions of Section 7 or Section 9 or Section 10 or sub-section (5) of Section 60, the same very Tribunal passes an order as an ‘Adjudicating Authority’ and the same Tribunal in the capacity of ‘judicial authority’ passes order under Section 8 or Section 45 of the Arbitration Act, 1996. As the Tribunal is empowered to pass orders in different capacities under different provisions of the Act…”

Therefore, while adjudicating upon an application u/s 7 of IBC, the NCLT ought to discharge its duty as a judicial authority, hence a reference to arbitration is not bad in law. While adjudicating an application u/s 7 or 9, the Adjudicating Authority is competent to decide upon a section 8 application under the Arbitration Act.

  • Over-riding effect of Arbitration Act over IBC

Section 238 of IBC provides overriding effect to IBC compared to any other law for the time being in force. Section 5 of the Arbitration Act also provides for a non-obstante clause. The rules of statutory interpretation state that in case of an inconsistency arising between two special legislations, the latter enacted legislation will have an overriding effect on the previously enacted legislation. However, this is not the rule of thumb. The Hon’ble Supreme Court in Life Insurance Corporation of India and Ors. v/s D.J.Bahadur & Ors. laid down that a statute can be treated as special legislation vis-à-vis one legislation but there may be situations where the special statute will be treated as a general statute vis-à-vis another special statute. The categorisation of special or general depends on the specific problem, the topic for decision and other criteria.

Providing a blanket overriding effect of IBC over all previous legislative enactments means going against the principles of statutory interpretation. The anatomy of the IBC is such that it does not deal with the determination of disputes and nor does it concern itself with fact-finding. The alpha and omega of IBC is to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders.  In contrast, the Arbitration Act is a complete code for resolution of disputes. The object of the code is to provide speedy resolution of disputes between the parties. Determination of rights and obligations is thus, not within the purview of IBC. Therefore, in an issue related to determination of rights and obligations, the IBC vis-à-vis Arbitration Act, would be considered as a general statute and should have no overriding effect. 

  • Scope for raising a ‘dispute’ in Section 7

The Innoventive Industries Ltd. case itself leaves scope for raising a dispute under Section 7 of IBC. It states that where the debt is not payable in law or in fact, a section 7 application cannot be admitted. The Hon’ble NCLT in Carnoustie Management (P.) Ltd. v/s CBS International Projects (P.) Ltd. has rightly pointed out that where the loan is itself disputed, the NCLT in a summary proceeding cannot adjudicate upon the existence of the loan, and such questions shall be decided by the competent forum. In other words, the statute mandates the NCLT to ascertain and record satisfaction as to the occurrence of default, and not go into the question of rights of the financial creditor or the corporate debtor.

Conclusion

Section 7 of IBC allows NCLT to admit an application on proof of debt and default but it is silent on the aspect where the debt which is being shown as default, is itself disputed. The IBC does not intend to provide a recovery forum to the creditors and should be used only when there exists a debt and default which can be ascertained by the adjudicating authority through summary adjudication. The process should not be used in a manner to threaten corporate debtors and a question of creditors right to claim the amount as debt, when disputed, should be adjudicated upon by a civil court or through arbitration.

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